I am a strong believer that eliminating your debt is the first step to becoming wealthy. Once you are debt free, there is nothing holding you back from saving a higher percentage of your income. Think about how much of your household income goes to credit card payments, car payments, and other miscellaneous debts. I’ll venture to say that it’s at least 20% of your take home pay. Saving an extra 20% of your income over 30 to 40 years will ALWAYS make you a millionaire, even if you make $35K for the rest of your life. There are three popular ways of methodically paying off your debt. I don’t want to tell you which one that I think you should do, because I think it has much to do with what kind of person you are. Here are the three methods for eliminating your debt.
The Debt-Snowball Method: This is the method that Dave Ramsey endorses for paying off your debt. The way this method works is by starting out listing your debts from smallest to largest. Attack the smallest debts first to build momentum to pay off the larger debts. This method focuses on the emotional and mental aspect of paying off debt. Ramsey believes that you will become more encouraged to pay off debts once you start seeing yourself paying off the smaller debts first. Also, he says that if you clean up the smaller debts first, then you’ll have more money to put towards paying off the larger debts. That’s where the “snowball” part comes into play. By the time you get to the largest debt, the debt snowball has become so large that you are able to pay it off very quickly. This method works best for those of us that are spenders at heart and have a hard time paying down debt as the first priority. Use this method if you want to feel some emotional feelings towards paying off your debt and you have a lot of little debts to clean up before you get to the big dogs.
The Interest Rate Method: This is the rival method to paying off debt to the debt snowball method. This is the most logical method in terms of doing the math and thinking about paying off debt as purely a mechanical task. This method shows us to list our debts from the largest interest rate percentage to the smallest interest rate percentage. So, find the debt carrying the largest interest rate and attack that one first since you are losing the most money on that debt. This method is for the logical thinker who wants to stop paying interest as quickly as possible. The problem with this method is that sometimes your largest debt is the one with the highest interest rate, so it feels like it takes you forever to pay it off. Dave Ramsey would contest that this method is inferior to his method for this reason. He believes that you may get discouraged by paying down your debt quickly and switch back to paying just the minimum payments. I think this method will work best for you if you are disciplined by nature with money and you have a smaller amount of large debts. If you look at your debts and it reads, $5,000 credit card, $9,000 car payment, and $7,000 student loan, I would use this method.
Pay the Oldest Debt First Some people tie an emotional relationship into their debt, and they want to pay off their oldest debts first. That student loan that has been lingering around, the car payment that won’t go away. This is another emotional way to approach paying off debt, and it may work for you if paying off lingering debts motivates you to pay off the new ones. Use this method if you have some debts that just felt like they will never go away.
Tell me what methods you have used in the past for paying down or paying off debt. I am personally doing the smallest to largest. Right now, we have student loans to attack, which are our largest debts. We are going to attack those once we have a larger take home pay when my wife starts working.